Policyholder Perspective

UK's Solvent Schemes Dealt Another Blow: Hopefully, the Coup de Grâce

The travesty that is the Solvent Scheme of Arrangement has been dealt another blow; one hopes a fatal one. A month after issuing a blistering attack on the practice, Lord Glennie entered final judgment this week refusing to sanction the Scottish Lion scheme. It is worth taking a long look at Lord Glennie’s lengthy opinion.

The issue, succinctly stated by the court, was: “Can it ever be fair to sanction a ‘solvent’ scheme of arrangement in the face of continuing creditor opposition to having their occurrence cover compulsorily terminated?” The court’s answer was, Probably Not.

Under UK law, an insurance company can wind up its operations under either an Insolvent Scheme of Arrangement or a Solvent Scheme of Arrangement. An Insolvent Scheme has US equivalents in our state-run insurance liquidation processes. However, Solvent Schemes are unique to the UK. They allow an otherwise solvent insurance company, including companies that sold occurrence policies for which the company has largely unquantifiable continuing obligations to its policyholders, to wind up operations by forcing policyholders to accept policy commutations. 

Solvent Schemes are governed by Section 899 of the Companies Act 2006 (although they have been around longer). The act requires 75% of the value of each class of creditors to approve the Scheme. The attacks on the British Aviation Insurance Scheme led to the current requirement that creditors with IBNR (Incurred But Not Reported) claims be treated separately from those with existing claims, with separate meetings and votes. 

The valuation of IBNR claims by Scheme administrators have led to numerous attacks. Those valuations are critical to the voting, since they determine the weight of each creditor’s vote. Objectors usually are US policyholders with IBNR long-tail claims under occurrence policies, usually environmental, product liability and toxic tort claims. That was the case in Scottish Lion as well. Whatever the merits of “actuarial science” in the context of liability coverage may be, it is certain that the projected value of the IBNR claims will be wrong, whether too high or too low. These valuations also determine the amount paid in the eventual commutation, once the Scheme is sanctioned.

The objections to Solvent Schemes can be summarized as follows:

  • Policyholders paid substantial premiums for occurrence-trigger policies, which are valuable and now irreplaceable assets
  • No amount of money paid in commutation will allow a policyholder to replace this coverage.
  • Unless the policyholder is in need of short-term cash, there is no benefit to these commutations for policyholders; all of the benefit goes to the insurance company and its owners and managers.
  • Nothing prevents a policyholder which wants a commutation from seeking one; there is no reason to force unwilling policyholders to do so. 

In the end, the court agreed, following the reasoning of the court which refused to approve the British Aviation scheme in 2006:

"If individual policyholders wish to compound the company's contingent liabilities to them, and to accept payment in full of an estimate of their claims, there is nothing to stop them doing so. But to compel dissentients to do so would ... require them to do that which it is unreasonable to require them to do."

That unreasonableness seems to me to stem from the fact that where the company is solvent it is unnecessary for the body of creditors or class of creditors to as a whole that there should be any scheme, still less a scheme forced upon unwilling participants. I respectfully agree with that reasoning.

The Court of Session is Scotland’s supreme civil court. The case may eventually end up before the new Supreme Court of the United Kingdom which opened on October first

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UPDATE [November 3, 2009]: PricewaterhouseCoopers, Scheme Advisors to Scottish Lion and many other effective and proposed solvent schemes has announced their intent to appeal Lord Glennie's decision.

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